Shares of Sogou (SOGO) tumbled more than 60% from their 52-week high in June due to concerns about the company's decelerating growth as it faces tough domestic rivals, a depreciating RMB, and trade tensions between the US and China. The Chinese tech company posted its third quarter numbers on Nov. 5, but its mixed results highlighted some tough headwinds.

Sogou's revenue grew 7% annually to $277 million, which missed estimates by about $5 million and marked its slowest growth since its IPO last year. Its non-GAAP net income fell 10% to $28 million, or $0.07 per ADS, which beat expectations by $0.07.

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Sogou expects its fourth quarter revenue to rise 5%-11% annually in dollar terms (11%-17% in RMB terms), which missed analyst expectations for 24% growth in US dollars. Sogou didn't provide any earnings guidance, but analysts expect a 20% drop -- which will likely be revised downwards due to the top line miss.

Trying to grow in Baidu's shadow

Sogou generated 92% of its revenue from its online search platform during the third quarter. Its total search revenue rose 13% annually to $255 million, fueled by better monetization and traffic growth. However, that growth was slightly throttled by a government-mandated 10-day suspension of Sogou's ad services in early July to "ensure compliance with government regulations."

Sogou's growth in search revenue looks decent, but its traffic acquisition costs (TAC) surged 58% annually to $135 million (49% of its revenue) due to price inflation and tougher competition. Sogou's TAC stayed roughly flat from the second quarter, but its total number of advertisers slipped 2% sequentially to 81,000 as its average revenue per advertiser fell 6% to $2,600.

In other words, Sogou is spending lots of cash to gain traffic, but the advertisers just aren't biting. That's probably because Sogou controls just 7% of China's online search market according to StatCounter. Baidu (BIDU 1.24%) controls 65% of the market, while Alibaba's Shenma ranks second with an 18% share.

Last quarter, Baidu's TAC rose just 25% annually and accounted for just 11% of its revenues. Its number of advertisers and revenue per advertiser also grew sequentially and annually, and it generates roughly 140% more revenue per advertiser than Sogou. Therefore Baidu isn't spending much cash to maintain its lead, but Sogou is spending an alarming amount of cash to preserve its tiny foothold.

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On the bright side, Sogou carved out a niche in third-party keyboards and voice searches with the Sogou Mobile Keyboard. That app -- which grew its daily active users (DAUs) 32% annually to 405 million during the quarter -- is also China's top voice search app and processes over 500 million voice queries daily.

Sogou could eventually leverage that app's strength to expand its search ecosystem. However, Baidu's Alexa-like DuerOS -- which had an installed base of 141 million hardware devices in September -- is already becoming a formidable rival.

Weighed down by uneven hardware sales

The rest of Sogou's revenue comes from its "other" businesses, which mainly consist of sales of AI-enabled hardware products like smart speakers, smartwatches, and translation devices. The unit's growth has been wobbly due to uneven demand for its devices and the discontinuation of its non-AI hardware.

Sogou's "other" revenues slid 33% annually to $21.3 million, mostly due to weaker sales of its smart hardware products. This indicates that Sogou's attempt to expand its search ecosystem with hardware could hit a brick wall as Baidu enlists more hardware makers into its DuerOS army.

We should recall that Sogou's TAC accounted for 78% of its cost of revenues during the quarter, which doesn't leave it much room to develop new hardware products. Sogou could try to partner with more third-party hardware makers to expand its ecosystem, but that could be tough to accomplish in Baidu's shadow.

The same old problems

Sogou is fighting a losing war against Baidu, which is clearly reflected in its decelerating sales growth, negative earnings growth, and surging expenses. Its gross margins (both GAAP and non-GAAP) contracted a whopping 12 percentage points annually to 37% during the quarter, and could slide even more as it tries to keep up with Baidu.

Sogou's stock looks inexpensive at 15 times forward earnings, but Baidu -- which has superior growth and a much wider moat -- trades at less than 18 times forward earnings. Therefore it still makes much more sense to buy Baidu than Sogou at these levels.